You can use a 1031 exchange when buying a business, but only the real estate portion of the purchase qualifies for tax deferral. Section 1031 covers real property held for business use or investment, and nothing else. Equipment, inventory, vehicles, goodwill, customer lists, licenses, and every other operational or intangible asset must be paid for with separate funds. The practical question is not whether the exchange is allowed, but how cleanly you can carve the real estate out of the rest of the deal.1Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
What Qualifies and What Doesn’t
Section 1031 defers capital gains tax when an investor exchanges one piece of real property for another of “like kind,” provided both are held for business use or investment. The Tax Cuts and Jobs Act of 2017 removed personal property from the statute entirely, which is why an entire operating business cannot ride inside a single exchange.1Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
Real property, defined broadly by Treasury regulations, includes land, buildings, and structures permanently affixed to the land, along with certain intangible interests in real estate like long-term leases and easements. Warehouses, stores, hotels, factories, restaurants, parking lots, and the fixtures inside them generally qualify.2GovInfo. 26 CFR 1.1031(a)-3 – Definition of Real Property The like-kind test is loose within real estate: a warehouse is like-kind to an office complex or a raw lot. Only U.S. real estate and foreign real estate fail the test against each other.
Everything else that comes with a business does not qualify. That means:
- Inventory, supplies, and stock in trade
- Kitchen equipment, machinery, tools, furniture, and computers
- Delivery vehicles and other titled personal property
- Goodwill, brand value, customer lists, and going-concern value
- Trade names, patents, proprietary software, and other intangibles
- Liquor licenses, franchise agreements, and other transferable permits
For service businesses and franchises, the intangibles frequently outweigh the real estate. When that happens, the exchange covers a modest slice of the total purchase price and you need other capital for the rest.
One further boundary worth flagging: property held primarily for sale is excluded. If you flip properties as a dealer rather than holding them for investment or business use, those properties sit outside Section 1031 no matter how the deed reads.1Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
How to Split the Purchase Price
The mechanics come down to allocation. The purchase agreement should assign a specific dollar amount to each category of asset: land, buildings, equipment, inventory, goodwill, licenses, and anything else changing hands. Only the amounts assigned to land and permanently affixed structures can be paid with exchange funds.
Consider a restaurant selling for $1.2 million. The contract might allocate $700,000 to the land and building, $150,000 to kitchen equipment and furniture, $50,000 to inventory, and $300,000 to goodwill and the liquor license. Exchange proceeds held by your qualified intermediary cover the $700,000. The other $500,000 comes from your own cash, seller financing, an SBA loan, or another source outside the exchange. Locking the allocation in early prevents a closing-day scramble and gives both sides a defensible position if the IRS ever asks.
Payment streams must stay separate. Exchange funds flow from the intermediary to the closing agent for the real estate. Non-qualifying assets are paid for through a different channel. Mixing the two risks disqualifying the entire exchange.
Boot Is Almost Certain in a Business Deal
“Boot” is any value you receive in the exchange that isn’t like-kind replacement real property. Boot is taxable to the extent of your gain, though you cannot recognize a loss through it.3Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips The statute limits recognized gain to the sum of cash and the fair market value of non-like-kind property received.1Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
Two forms show up most often:
- Cash boot. Sale proceeds you don’t reinvest into replacement real property. Selling for $500,000 and putting only $450,000 into the replacement leaves $50,000 of cash boot.
- Mortgage boot, or debt relief. If the mortgage on the replacement property is smaller than the mortgage on the property you sold, the difference is boot. A $300,000 loan on the old property replaced by a $250,000 loan on the new one creates $50,000 of mortgage boot.
Business acquisitions almost always produce some boot because operational and intangible assets pull dollars away from the real estate side. The realistic goal is not zero boot. It is a clean allocation that pushes as much of your exchange proceeds as possible into the qualifying real estate.
Ownership Structures That Sidestep the Problem
If your interest is really in owning business real estate rather than running the business, two structures let you use exchange funds for the whole investment.
A triple-net (NNN) lease property is one where you own the land and building and the tenant handles taxes, insurance, and maintenance. Chain restaurants, pharmacies, banks, and national retailers commonly sit in NNN properties. You collect rent from an operating business without owning the business itself, and the entire investment is real property for 1031 purposes.
Delaware Statutory Trusts (DSTs) hold title to real property while investors buy beneficial interests in the trust. The IRS has treated those fractional interests as qualifying real property since Revenue Ruling 2004-86. DSTs give an exchanger passive access to institutional-grade commercial real estate without direct management. For someone finishing an exchange late in the 180-day window without a clean acquisition target, they can absorb proceeds that would otherwise become taxable boot.
The Deadlines Still Apply
Two deadlines govern every deferred exchange, and missing either kills the deferral entirely.
From the day you close the sale of the relinquished property, you have 45 days to identify potential replacement properties in writing, signed and delivered to your qualified intermediary, with specific addresses or legal descriptions.1Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment You can identify up to three properties of any value, or more than three if their combined fair market value does not exceed 200 percent of what you sold.
You then have until the earlier of 180 days after the sale, or the due date (including extensions) of that year’s tax return, to close on the replacement property.1Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment A late-year sale can hit the tax-filing deadline before day 180 runs out; filing an extension preserves the full window.
The Qualified Intermediary
You cannot touch the sale proceeds between transactions. If the IRS finds you had control over or access to the cash at any point, the exchange fails and the full gain becomes taxable.4Internal Revenue Service. Sales, Trades, Exchanges A qualified intermediary holds the funds in a segregated account and releases them directly to the closing agent when you buy the replacement property. Treasury regulations treat this as a safe harbor against constructive receipt.5Internal Revenue Service. Revenue Procedure 2003-39
You cannot act as your own intermediary. Your real estate agent, broker, accountant, or attorney is also disqualified if they have worked for you in that capacity within the previous two years.6Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031 Fees for a standard exchange generally run $800 to $1,500, with complex multi-asset deals costing more.
Reporting a Split Deal
A completed exchange gets reported on Form 8824 with the tax return for the year you transferred the relinquished property.7Internal Revenue Service. Instructions for Form 8824 When the transaction involves both real property and non-qualifying business assets, the IRS treats it as a multi-asset exchange. Skip the standard gain calculation lines (12 through 18) on the form and attach a separate statement showing how you split the realized and recognized gain across the different asset groups. Recognized gain on the non-real-estate portion goes on Schedule D, Form 4797, or Form 6252, depending on the character of the gain.8Internal Revenue Service. 2025 Instructions for Form 8824
Your basis in the replacement real estate carries over from the property you sold, adjusted for cash paid, boot received, and gain recognized. Any debt the other party assumes counts as money you received.1Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment That carryover basis is usually well below the purchase price, which shapes future depreciation deductions and taxable gain on any later sale. Keep detailed records of every figure in the exchange.
Extra Risk When Buying a Business
Business acquisitions have more moving parts than a straight real estate purchase: operational due diligence, lease assignments, license transfers, employee arrangements, seller financing terms. Any of those can push a closing past day 180. There is no partial credit. If the deadline slips, the entire transaction is reclassified as a taxable sale, the intermediary releases the funds to you, and you owe capital gains tax on the full original gain.
Experienced exchangers build time buffers into the schedule and identify backup replacement properties inside the 45-day window specifically for this reason. Where feasible, starting the replacement search before listing the relinquished property gives the widest working window. And because so much of a business purchase is not real estate anyway, lining up separate financing for the equipment, inventory, and intangibles early keeps the exchange side of the deal from being held up by the operational side.